VIII. EXPLANATION OF TREATY PROVISIONS

Set forth below is a detailed, article-by-article explanation of the proposed income tax treaty and, where applicable, the proposed protocol between the United States and Indonesia, followed by an explanation of the letters exchanged when the proposed treaty and protocol were signed.

ARTICLE 1. PERSONAL SCOPE

Generally, the proposed treaty applies to residents of the United States or Indonesia or of both countries. For purposes of the proposed treaty, the definition of a resident of the United States or Indonesia is set forth in the article on fiscal residence (Article 4). There are certain exceptions to the general application of the proposed treaty to residents of the United States or Indonesia. For example, the article dealing with general rules of taxation (Article 28) provides, among other things, that either country reserves the right to tax its citizens (and in certain cases former citizens) or residents in accordance with its domestic laws as if the proposed treaty were not in effect. In addition, other provisions of the proposed treaty such as provisions related to source of income (Article 7), related persons (Article 10), nondiscrimination (Article 24), and the exchange of information (Article 26) may apply to persons not specified in Article 1.

ARTICLE 2. TAXES COVERED

In the case of Indonesia, the proposed treaty applies to the income tax (pajak penghasilan 1984), and to the extent provided in such income tax, the company tax (pajak perseroan 1925), and the tax on interest, dividends, and royalties (pajak atas bunga, dividen dan royalty 1970).

In the case of the United States, the proposed treaty applies to the Federal income taxes imposed under the Internal Revenue Code (the "Code"). It does not apply, however, to the accumulated earnings tax, the personal holding company tax, or social security taxes. In addition, the proposed treaty generally does not apply to non-income taxes such as excise,' unemployment, estate, or gift taxes. Likewise, State and local taxes are not covered by the proposed treaty.

The proposed treaty contains a provision generally found in U.S. income tax treaties to the effect that it also will apply to any identical or substantially similar taxes that either country may subsequently impose.

Notwithstanding these general rules, the nondiscrimination provisions of the proposed treaty (Article 24) apply to all taxes of every kind imposed at the national level by the United States or Indonesia. In addition, the exchange of information provisions of the proposed treaty (Article 26) apply to all taxes of every kind imposed by the two countries at the national level.

7 The excise tax imposed on insurance premiums paid to foreign insurers is not covered under the proposed treaty, although this tax is a covered tax under the U.S. model treaty, as well as under some recent U.S. income tax treaties (e.g., the treaties with France, Hungary, and Cyprus). The preferred U.S. treaty position for many countries does not include coverage of this

excise tax.

ARTICLE 3. GENERAL DEFINITIONS

The proposed treaty contains certain of the standard definitions found in most U.S. income tax treaties.

The term "Indonesia" means the Republic of Indonesia, including the adjacent seas over which the Republic of Indonesia has sovereignty, sovereign rights or jurisdictions in accordance with the provisions of the 1982 United Nations Convention on the Law of the Sea.

The "United States" means the United States of America, but does not include Puerto Rico, the Virgin Islands, Guam or any other U.S. possession or territory. When used in a geographical sense, the term includes the 50 States, the District of Columbia, and those parts of the continental shelf and adjacent seas over which the United States has sovereignty, sovereign rights, or other rights in accordance with international law.

The term "one of the Contracting States" or "the other Contracting State" means Indonesia or the United States, as the context requires.

The term "person" is defined to include an individual, a partnership, a company, an estate, a trust, or any other body of persons. The term "company" means any body corporate or any entity which is treated as a body corporate for tax purposes.

The Indonesian competent authority is the Minister of Finance, or his authorized representative.

The U.S. competent authority is the Secretary of the Treasury or his authorized representative. The U.S. competent authority function has been delegated to the Commissioner of Internal Revenue, who has redelegated the authority to the Assistant Commissioner (International) of the IRS. On interpretive issues, the latter acts with the concurrence of the Associate Chief Counsel (International) of the IRS.

The terms "Indonesian tax" and "United States tax" mean the taxes imposed by the two countries to which the proposed treaty applies pursuant to the article setting forth taxes covered (Article 2). These terms do not include penalty or interest charges. However, under the proposed treaty's provisions for mutual agreement procedure (Article 25), the competent authorities of the two countries may attempt to ensure that penalties or interest are imposed or paid in a manner consistent with the objectives of the proposed treaty.

The proposed treaty defines "international traffic" as any transport by a ship or aircraft, except where the transport is solely between places in the other country. Accordingly, with respect to an Indonesian enterprise, purely domestic transport in the United States is excluded from this definition.

The proposed treaty provides that any term which it does not define is to have the meaning it has under the applicable law of the country whose tax is being determined, unless the context otherwise requires. If the meaning of an undefined term under one country's law is different from its meaning under the other country's law, or is not readily determinable under one country's law, the competent authorities of the two countries may establish a common meaning for the undefined term.

ARTICLE 4. FISCAL RESIDENCE

The assignment of a country of residence is important because the benefits of the proposed treaty generally are available only to a resident of one of the countries as the term is defined by the proposed treaty. Furthermore, double taxation is often avoided by the proposed treaty assigning one of the countries as the country of residence where, under the laws of the countries, a person is a resident of both.

Under U.S. law, residence of an individual is important because a resident alien is taxed on his or her worldwide income, whereas a nonresident alien is taxed only on U.S. source income and on income that is effectively connected with a U.S. trade or business. A company is a resident of the United States if it is organized in the United States. Under the standards for determining residence provided in the 1984 Act, an individual who spends substantial time in the United States in any year or over a three-year period generally is a U.S. resident. A permanent resident for immigration purposes also is a U.S. resident. The standards for determining residence provided in the 1984 Act do not alone determine the residence of a U.S. citizen for the purpose of any U.S. tax treaty (such as a treaty that benefits residents, rather than citizens, of the United States).

Under the proposed treaty, the term "resident of a Contracting State" means any person who under the laws of either Indonesia or the United States is subject to tax in that country as a resident by reason of his or her domicile, residence, place of incorporation, place of management or any other criterion of a similar nature. For purposes of United States tax, a partnership, estate, or trust is considered a resident of the United States only to the extent that its income is subject to tax, either in its hands or in the hands of its partners or beneficiaries, as the income of a U.S. resident. For example, if the share of United States beneficiaries in the income of a United States trust is only one-half, Indonesia would have to reduce its withholding tax (to the extent required by the applicable provision of the proposed treaty) on only one-half of the Indonesian source income paid to the trust. A similar rule is not required in the case of Indonesia, the Committee understands, because under Indonesia's internal tax laws, partnerships and trusts are taxed as corporations, and estates are taxed as individuals. The references to "subject to tax" mentioned above do not cause a tax-exempt organization to lose its status as a resident of one of the countries under the proposed treaty.

Under this article of the proposed treaty, a U.S. citizen is not considered a U.S. resident for treaty purposes. As a result, U.S. citizens residing overseas (in countries other than Indonesia) generally are not entitled to the benefits of the proposed treaty as U.S. residents. Only in very few U.S. income tax treaties has the United States negotiated coverage for nonresident U.S. citizens.

The fiscal residence article also provides a set of "tie-breaker" rules to determine residence in the case of an individual who, under the general residence rules, is considered a resident of both the United States and Indonesia. These rules are similar to those contained in the U.S. model treaty. In the case of a dual resident

individual, that individual is deemed for all purposes of the proposed treaty to be a resident only of the country in which (in order of priority) the individual has his or her permanent home (that is, the place where an individual dwells with his or her family), the center of his or her vital interests (i.e., his or her closest economic and personal relations), his or her habitual abode, or his or her citizenship. If the residence of an individual cannot be determined by these tests, applied in the order stated, the competent authorities of the two countries are to settle the question of residence by mutual agreement.

If a company (as defined in Article 3) is considered a resident of both Indonesia and the United States under the general residency determination rules, then for purposes of the proposed treaty, it is treated as a resident of the country in which it is organized or incorporated.

ARTICLE 5. PERMANENT ESTABLISHMENT

The proposed treaty contains a definition of the term "permanent establishment" that, subject to certain modifications, generally follows the pattern of other recent U.S. income tax treaties, the U.S. model treaty, and the OECD model treaty.

The permanent establishment concept is one of the basic devices used in income tax treaties to limit the taxing jurisdiction of the host country and thus mitigate double taxation. Generally, a resident of one country is not taxable by the other country on its business profits unless those profits are attributable to a permanent establishment of the resident in that other country. In addition, the permanent establishment concept is used to determine whether the reduced rates of, or exemptions from, tax provided for dividends, interest, and royalties apply, or whether those amounts are taxed as business profits.

In general terms, under the proposed treaty, a permanent establishment is a fixed place of business through which a resident of one country engages in business in the other country. A permanent establishment includes (but is not limited to) a place of management, branch, office, factory, workshop, farm, plantation, warehouse, mine, oil or gas well, quarry, or other place of extraction of natural resources. A permanent establishment also includes a building site, construction, assembly, or installation project, or supervisory activities in connection therewith, or an installation, drilling rig, or ship used for the exploration or exploitation of natural resources, but only if the site, project, drilling rig, etc. lasts for more than 120 days. In addition, a permanent establishment includes the furnishing of services, including consultancy services, through employees or other personnel engaged for such purposes, but only where such activities continue with respect to that or a related project for more than 120 days within any consecutive 12month period. A permanent establishment does not exist, however, as a result of the furnishing of such services in any taxable year in which the services are rendered in that country for a period or periods aggregating less than 30 days (although such period of days are included in determining whether the 120-day test is met).

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The general permanent establishment rule is modified to provide that a fixed place of business in one country which is used by a resident of the other country only for any or all of a number of specified activities does not constitute a permanent establishment. These activities include the use of facilities solely for storing or displaying merchandise belonging to the resident; the maintenance of a stock of goods belonging to the resident solely for the purpose of storage or display or for processing by another person; and the maintenance of a fixed place of business solely to purchase goods or merchandise or to collect information for the resident. Additionally, the maintenance of a fixed place of business solely for the purpose of advertising, the supplying of information, scientific research, or similar preparatory or auxiliary activities for the resident does not, in and of itself, constitute a permanent establishment. Moreover, pursuant to the proposed protocol, the use of facilities or the maintenance of a stock of goods or merchandise belonging to an enterprise for the purpose of occasional delivery of such goods or merchandise does not constitute a permanent establishment.9

If a resident of one country maintains an agent in the other country who has, and habitually exercises, the authority to conclude contracts in that other country on behalf of the resident, then the resident generally is deemed to have a permanent establishment in that other country. This rule does not apply where the contracting authority is limited to those activities, such as storage, display, or delivery of merchandise (described in the preceding paragraph) that are excluded from the definition of permanent establishment. Additionally, if the resident maintains an agent in the other country who lacks the authority to conclude contracts on behalf of the resident, but who habitually maintains in the other country a stock of goods or merchandise owned by the resident from which he or she regularly fills orders or makes deliveries and who conducts additional activities which contribute to the sale of the goods or merchandise, then the resident is deemed to have a permanent establishment in the other country. The proposed treaty contains the usual provision that the agency rule does not apply if the agent is a broker, general commission agent, or other agent of independent status acting in the ordinary course of its business.

The fact that a company which is a resident of one country controls, or is controlled by, a company which is a resident of the other country or which is engaged in business in that other country (whether through a permanent establishment or otherwise) does not in and of itself constitute either company a permanent establishment of the other.

* Paragraph 3(b) of Article 5 of the proposed treaty as reflected in Treaty Doc. 100-22 (100th Congress, 2d Session) erroneously states that a permanent establishment shall not be deemed to exist by reason of the maintenance of a stock of goods or merchandise belonging to the resident "solely for the purpose of processing by play." The Committee understands that representatives of the Treasury Department have confirmed that paragraph 3(b) should properly read, "the maintenance of a stock of goods or merchandise belonging to the resident solely for the purpose of storage or display."

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A permanent establishment would exist, however, if such a facility were used for the purpose of making deliveries on a regular basis.